At first glance, it’s a perfectly reasonable thesis. Inflation rates are still at 40-year highs and the Fed is serious about raising rates to fight them. Neither is particularly good for business. Plus, it’s only natural to seek out a quick and easy-to-digest explanation for big market moves.
Although investors may have a gut reaction to sell every time new, alarming inflation data gets announced, historically, high inflation alone has not been directly responsible for market downturns.
Even when prices are rising steadily, investors can cope, sending shares up in proportion to inflation, he said. It’s when economists sound the alarm bells about future price spikes that investors head for the exit.
Heightened inflation plays an important role in market returns, said Michael Batnick with Ritholtz Wealth Management.
Equities can also provide a pretty decent hedge against inflation in the long run.
“We believe stocks are one of the best places to be in a rising inflation world,” wrote Tony DeSpirito, managing director at BlackRock, in a recent note. BlackRock looked at stock performance dating back to 1920 and found that as long as inflation doesn’t cross 10%, equities continue to perform relatively well.
But he added that rising inflation and rates is also stoking higher volatility in stocks, and investing is getting trickier.
Investors can prepare their portfolios to better weather high rates of inflation. Value stocks, with more stable near-term cash flows, have the upper hand on growth stocks in an inflating environment, said DeSpirito.
The S&P 500 Growth Index, which tracks stocks that have the best three-year growth in revenue and earnings per share has fallen nearly 15% in the past year. The S&P 500 Value Index, which tracks stocks with the best valuations, dropped by just 4.8% over the same period. The S&P 500 has lost about 10%.
The energy sector also tends to outperform the rest of the market during periods of high inflation. The sector had an annualized return of 14% between 1968 and 1981 and will likely have an outsized impact on earnings estimates this quarter, according to the Wells Fargo Investment Institute. Energy earnings in the S&P 500 are expected to grow by nearly 205% this quarter while forecasters say the rest of the S&P 500 will decline by 2%.
But the best hedge against inflation is patience.
Between 1966 and 1981, a period encompassing much of the stagflation era, investors in the US stock market lost more than 35% after adjusting for inflation, according to analysis by Ben Carlson, also with Ritholtz Wealth Management.
Those who stuck it out, however, ended up on top. Between 1966 and 1999, nominal annual returns were 12.3% against a 5% annual inflation rate, leaving investors with 7.3% real returns over 34 years.
Oil prices are falling, is gas next?
Gas prices are no longer at record highs but filling up at the pump is still a wallet-busting event. So when will US drivers get a break?
The national average for a gallon of gas stood at $4.75 on Thursday, according to AAA. That’s about 27 cents lower than the record high of $5.02 hit on June 14 but $1.62 higher than this time last year.
Gas could reach $4 to $4.25 per gallon by mid-August, providing that oil prices don’t reverse course, said Patrick De Haan, head of petroleum analysis at GasBuddy.
When oil prices increase, gas stations usually follow with a lag time of two to three days, said De Haan. When oil prices fall, however, gas stations are slower to cut prices to recapture lost margins. The industry calls the phenomenon “rockets and feathers,” as in gas prices go up like a rocket and come down like a feather.
Gas stations have little incentive to cut their prices as demand for gas has remained strong this summer. Oil prices could also rise based on new developments in Russian oil exports tied to the war in Ukraine or hurricanes hitting US oil infrastructure along the Gulf Coast.
“I wouldn’t put away the fives used in gas price signs quite yet,” said Tom Kloza, global head of energy analysis for OPIS.
Mortgage rates are falling but housing remains unaffordable
US mortgage rates just notched their largest one-week decline since December 2008.
The 30-year fixed-rate mortgage averaged 5.3% in the week ending July 7, down from 5.7% the week before, according to Freddie Mac.
Inflation is also dissuading potential homebuyers.
One year ago, a buyer who put 20% down on a median priced $390,000 home and financed the rest with a 30-year, fixed-rate mortgage at an average rate of 2.90% had a monthly mortgage payment of $1,299, according to calculations from Freddie Mac.
Today, a homeowner buying the same priced house with an average rate of 5.30% would pay $1,733 a month in principal and interest. That’s $434 more each month.
There is a twinkle of hope for potential homebuyers who are willing to hold out. Mortgage applications dropped 5.4% in the week ending July 1 from the week before, according to the Mortgage Bankers Association, and the number of homes on the market is increasing. Eventually sellers could be forced to compete and lower prices, we just don’t know how long it will take.
Up next
The US jobs report for June will be released at 8:30am ET.
